Does it make sense for a company’s sales to be shrinking yet its share price to soar? One FTSE 100 company has been in just that position lately.
Its share price has grown 41% in 2024, yet in its most recent annual results (to the end of September), sales actually declined slightly compared to the prior year period.
This is a stock I used to hold but sold some years ago, meaning I have missed out on that jump of over two-fifths in share price this year. On top of that, by not owning the share I am missing out on a juicy dividend yield, that currently stands at 6%.
Ought I to add it back into my portfolio? I do not think so and will explain some pros and cons underpinning my choice below.
Well-known business in a mature industry
The company in question is Imperial Brands (LSE: IMB).
Its old name of Imperial Tobacco was clearer about how the company makes its money. It makes and sells cigarettes under a variety of brands worldwide. It also offers non-cigarette formats although it has been pushing less aggressively than some rivals into that market, focusing instead on growing its market share in the declining but still huge cigarette space.
Making money in declining markets
I mentioned above that sales revenues fell in the company’s most recent financial year, but in fairness that was only by 0.2%. They still came in at £32bn, which I see as substantial.
That was the third consecutive period of declining sales though, reflecting Imperial’s focus on a market that is shrinking over time.
The bottom line did better, with earnings per share jumping 19% year on year.
That reflects the pricing power of companies selling addictive products with premium brands. They can push the price up to compensate for falling sales.
Profits issues
In fact, that is exactly what seems to be happening with this particular FTSE 100 business. Pricing moved up 7.8% yet sales revenues still fell slightly, meaning that sales volumes declined more than revenues. For cigarettes at least, I see that as indicative of the likely long-term trend.
At some point, pricing power reaches its limits as spiralling cost increases push down demand even more, while manufacturing and marketing economies of scale become harder to maintain.
That is where I think rivals such as British American Tobacco may have an edge. For now, Imperial’s less ambitious push into non-cigarette products has let it save money it might otherwise spend trying to build demand. Longer term, though, the strategy could mean profits fall sharply as volumes decline.
Potentially good value – or a value trap?
Despite the stock soaring this year, it still trades on a price-to-earnings ratio of under 9.
With Imperial’s powerful brand portfolio, strong cash flow generation and generous dividend yield, that could turn out to be good value.
But the dividend was cut as recently as four years ago and I fear the run-up in share price this year perhaps overemphasises short-term profitability rather than what I see as long-term challenges to Imperial’s business model.
So I have no plans to buy shares again in the firm.
